A Platform War Erupts in the Foreign Exchange Market

Traditionally, when traders at AXA Investment Managers, the
London-based arm of the big French insurance company, wanted to
buy or sell currencies, they picked up the phone and called the
firms bank, JPMorgan Chase & Co. Then in 2007,
AXAs traders began using an electronic
currency-­trading platform, FXall, for many of their
transactions. But with new technology multiplying the number of
potential trading venues, AXA is now undergoing another shift.
It is in the process of moving most of its currency business to
a new platform, called TradingScreen, a step it hopes will
enhance and simplify its trading activities, says Lee Sanders,
the firms London head of FX and money market
operations.

We want one screen with all the capabilities,
says Sanders, whose firm trades about $300 million a year
in currencies. Among other bells and whistles, TradingScreen
attracted AXA with its extensive range of algorithmic trading,
flexibility in enabling users to set their own risk parameters
and transaction cost analysis tools to help AXA ensure it is
getting the best currency deals. TradingScreen is
bringing more ingenuity and enhancements to the market than
FXall, Sanders says. We want to stay ahead of the
curve.

A platform war is intensifying in the global foreign
exchange market, with more than half a dozen entrants jumping
into the space in the past few months. Its still too
early to know which platforms will emerge as winners, but the
proliferation of venues is already sparking declines in
already-low trading costs, with banks earning less on each
trade, in a situation similar to whats happened in equity
markets over the past decade. One banker estimates that revenue
per trade has dropped by about 9 percent over the past year
through a narrowing of bid-offer spreads.

This is the beginning of a big change in FX
trading, says Rebecca Healey, a senior analyst with
financial consulting firm TABB Group in London. A
revolution in technology is taking place, and this is just the
tip of the iceberg.

Although electronic trading has been part of the FX market
for many years, it traditionally focused on interbank trading.
Just two players  ICAPs EBS and Thomson Reuters
 dominate that segment today, with a combined market
share of roughly 80 percent.

The rise of new players has effectively spawned four
distinct market segments: the interbank market, which has
attracted new entrants, such as Currenex and traFXpure;
a new wave of platforms like FXall, FX Connect and tpSpotdeal,
which link end users like AXA with multiple banks; single-bank
proprietary platforms such as Deutsche Banks Autobahn and
Barclayss BARX FX, which offer a wide range of customized
services to clients; and so-called aggregator platforms like
TradingScreen and MarketPrizm, which offer end users a variety
of possibilities, such as multiple-bank price streaming,
single-bank proprietary feeds and even access to other
electronic networks.

There are new market participants coming in, new
methods of trading, and all in all its a huge growth
opportunity, says Healey. Some sophisticated traders now
have seven screens on each of their foreign exchange desks just
to keep up with the latest technology.

Although the proliferation of trading possibilities is
shaking up the FX market, the big banks that have long
dominated currency trading are seeing their market shares rise.
To stay in this increasingly competitive game, banks have to
spend hundreds of millions of dollars to acquire the latest
technology; only behemoths like Barclays, Deutsche and JPMorgan
can afford to make that kind of investment.

If you imagine the FX trading market like a funnel,
the rash of new platforms has widened the mouth
considerably, says Marc Chandler, global head of FX at
Brown Brothers Harriman & Co. in New York. But the
narrow end, where most of the trading takes place, is getting
even smaller as five big banks continue to dominate the
market.

One of the drivers of the multibank platforms was the series
of federal and state lawsuits filed against two custodial
banks, State Street Corp. and Bank of New York Mellon Corp.,
alleging that they had overcharged for FX transactions. Both
have denied the allegations.

At issue in those lawsuits was whether the two banks were
offering clients the most-attractive prices for currency trades
on the days those trades were recorded. The U.S.
governments lawsuit alleges that BNY Mellon used the
worst price of the day, even if the trades occurred at a time
when prices were better for the client.

Although the suits have not been resolved, the allegations
were disturbing enough to make institutional investors take
another look at their currency trading to see if they were
getting the most-attractive market prices, or what is known as
best execution.

Simultaneously, in Europe institutional investors have been
looking to overhaul their trading following the 2007
introduction of the European Unions Markets in Financial
Instruments Directive, which requires institutions to show
their clients that they are getting best execution.

Michael OBrien, head of global trading at asset
manager Eaton Vance Corp., says his firm has implemented a
best-execution policy and uses platforms to get quotes in
liquid currencies from multiple dealers, from which it chooses
the best quote available. Electronic trading has lowered
our transaction costs as measured by the bid-offer,
OBrien says. Five years ago most of our foreign
exchange business was on the phone.

Unlike equities, the spot foreign exchange market has never
involved an actual exchange. Currencies trade over the counter,
and there can be as many prices as there are market makers. The
only way an institutional investor or other end user can be
sure of getting anything like the best execution price is to
compare quotes offered by a large number of banks.

Institutions like AXA and Eaton Vance that formerly relied
on just one or two banks for their FX dealings now need to
compare quotes from ten or more institutions to satisfy clients
that each trade was conducted at the most attractive rate.
Coming online nearly every month, new platforms share one
feature: the ability to compare quotes. Some involve what is
known as request for quotation, or RFQ, in which they basically
post a potential trade online and ask banks to bid on it.
Alternatively, some services offer so-called streaming quotes,
in which the banks put their buy and sell offers for currency
pairs, such as dollar-euro or dollar-yen, online.

My goal is to give the traders who work for me as many
tools as possible and let them pick whats most
appropriate for any given trade, OBrien says.
Each platform typically offers something unique that is
useful to us in certain circumstances.

For example, some platforms allow him to trade using
computer algorithms, which chop up big trades into smaller
pieces. That technique is useful because it disguises the fact
that an asset manager is making a big purchase or sale of a
currency; its harder for other market participants to
adjust their prices and profit at the asset managers
expense. Traders say Deutsche Bank has a particularly strong
algorithmic offering. Another type of platform, such as EBS,
goes out to 20 banks and gets quotes without revealing who the
client is.

OBrien believes there are more platforms today than
the market can ultimately support, but he says the technology
is so impressive that its worth waiting to see which ones
emerge as the winners.

It is a very daunting time to be keeping track,
because the changes are occurring so fast and from different
angles, says Javier Paz, who follows foreign exchange
trading for Boston-based research firm Aite Group. I
think the markets are still in flux and will remain so for the
next year or so, until we can tell with certainty that one
model seems to be prevailing.

Although advances in technology have produced some clear
gains for currency traders, there have also been some
distinct downsides from the point of view of institutional
traders. Perhaps the biggest concern is the growth of high
frequency trading, which has roiled equity markets in recent
years. Typically, high frequency traders go in and out of the
market in a fraction of a second, posting bids and then
removing them almost instantly, to the detriment of regular,
slower traders like institutional investors and banks.

In fact, so great was the concern about market manipulation
by high frequency traders that market volume on one of the
largest trading venues, EBS, declined by 50 percent between
July 2011 and July 2012. Several reasons were advanced for the
drop, but one thing was clear: EBSs traditional client
base was abandoning the platform for other venues  an
apparent snub by banks concerned about the influence of high
frequency traders on the market.

In response, EBSs owner, ICAP, moved to repair its
tarnished image. In March 2012 it named a new CEO, Gil
Mandelzis, to run EBS. Mandelzis is co-founder and chairman of
Traiana, a firm used by banks for its automated
posttrade processing and risk management that ICAP bought in
2007 for $247 million. (ICAP sold a 12 percent stake in
Traiana to seven major banks in January.)

By September, Mandelzis had pushed through a number of rule
changes that make it more expensive for high frequency traders
to dart in and out of the market to the disadvantage of
more-traditional traders.